Can You Contribute to Your IRA While on Social Security?

Understanding the interplay between Social Security benefits and Individual Retirement Accounts (IRAs) is important for retirees looking to optimize their financial strategies. With many Americans relying on both sources of income during retirement, knowing whether you can contribute to an IRA while receiving Social Security is a common concern.

This article explores key aspects such as eligibility requirements, contribution limits, and potential penalties associated with IRAs in the context of Social Security benefits.

Earned Income Basics

To determine IRA contribution eligibility while receiving Social Security benefits, it’s essential to understand earned income. The IRS defines earned income as wages, salaries, tips, and other taxable employee pay, as well as net earnings from self-employment. Social Security benefits, pensions, annuities, and investment income are categorized as unearned income, which does not qualify for IRA contributions.

Retirees often generate earned income through part-time work or freelance opportunities, allowing them to contribute to an IRA. For example, a retiree working as a consultant or part-time teacher can contribute up to their earned income amount or the annual contribution limit, whichever is lower. If Social Security is your only income source, IRA contributions are not permitted. This distinction underscores the importance of planning for earned income opportunities during retirement.

Traditional and Roth IRA Eligibility

When contributing to a Traditional or Roth IRA while receiving Social Security benefits, understanding eligibility criteria is key. For a Traditional IRA, individuals must be under age 73 at the end of the year, as outlined by the SECURE Act 2.0. Contributions may be tax-deductible, depending on income level and whether the individual or their spouse is covered by a workplace retirement plan. Deductibility phases out for single filers with modified adjusted gross income (MAGI) between $68,000 and $78,000, and for married couples filing jointly with MAGI between $109,000 and $129,000.

Roth IRA contributions, while not tax-deductible, provide tax-free withdrawals in retirement. Eligibility is determined by income limits, which are adjusted annually. For 2024, single filers can make full contributions with a MAGI up to $153,000, while those earning between $153,000 and $168,000 can contribute a reduced amount. Married couples filing jointly can contribute fully if MAGI is up to $228,000, with reduced contributions allowed up to $243,000.

Contribution Limits

IRA contribution limits play a critical role in retirement planning. For 2024, the IRS set the annual contribution limit at $7,000 for individuals under 50. Those aged 50 and above can contribute an additional $1,000 under the catch-up provision, for a total limit of $8,000. These limits apply to both Traditional and Roth IRAs.

Contributions cannot exceed earned income. For example, if an individual earns $5,000 in a year, their maximum contribution is capped at $5,000, even if the annual limit is higher. Exceeding these limits triggers a 6% excise tax on the excess amount each year until corrected. Understanding these rules helps retirees align contributions with their income and avoid penalties.

Spousal IRA Option

The Spousal IRA allows a working spouse to contribute to an IRA on behalf of a non-working or low-earning spouse. This option is especially useful for couples where one partner has little or no earned income. The non-working spouse can enjoy the same contribution limits as the working spouse, effectively doubling the couple’s potential retirement savings.

For married couples filing jointly, total contributions to both spouses’ IRAs can reach $14,000 annually, or $16,000 if both are eligible for catch-up contributions. This provision ensures that households with unequal earning situations can still secure a strong financial future.

Penalties for Ineligible Contributions

Failing to follow IRA contribution rules can result in significant penalties. The IRS levies a 6% excise tax annually on ineligible contributions until corrected. For example, contributing $2,000 beyond the allowable limit would result in a $120 tax each year the excess remains in the account.

To avoid or rectify penalties, individuals can withdraw the excess contribution and any associated earnings before the tax filing deadline. Earnings on the excess are taxed as income and may incur a 10% early withdrawal penalty if the account holder is under 59½. For instance, if the excess generated $100 in earnings, those earnings would be taxed and potentially penalized.

In cases of reasonable error, taxpayers may qualify for relief if they take prompt corrective action. Filing IRS Form 5329 is required to report the excise tax. Consulting a tax professional is often advisable to navigate these situations effectively.

Distribution Rules and Tax Considerations

IRA distribution rules are essential for retirees managing Social Security benefits. Traditional IRAs require Required Minimum Distributions (RMDs) starting at age 73, as updated by the SECURE Act 2.0. The RMD amount is calculated annually based on the account balance and IRS tables. For example, a retiree with a $500,000 Traditional IRA at age 73 would have an RMD of approximately $19,231.

Roth IRAs, by contrast, are not subject to RMDs during the account holder’s lifetime, offering flexibility for retirees who want to minimize taxable income or leave assets to heirs. However, Roth withdrawals are only tax-free if the account has been open for at least five years and the account holder is over 59½. Early withdrawals of earnings may be taxed and penalized.

For retirees receiving Social Security, the timing and size of IRA distributions can influence the taxation of benefits. Up to 85% of Social Security income may become taxable if combined income—defined as adjusted gross income plus nontaxable interest and half of Social Security benefits—exceeds $34,000 for single filers or $44,000 for joint filers. Strategic planning, such as delaying RMDs or utilizing Roth IRA withdrawals, can help reduce this tax burden. Working with a financial advisor to coordinate distributions and Social Security benefits is a prudent approach to optimize tax efficiency.